After working hard to grow your small business, you likely want to ensure it will continue to operate well after you’re gone. Key person life insurance can make it easier for your company to succeed long term, no matter what the future brings.
By providing a source of funds after your passing, this insurance can help your employees navigate an otherwise difficult time. Here’s what you need to know.
What Is Key Person Insurance?
Key person insurance is a life insurance policy that protects the business when the owner or an important management team member passes away. The policy’s death benefit provides the funding necessary to keep the business solvent during a period when it may otherwise be financially vulnerable.
A key person, or “key man,” life insurance policy is important for small- and medium-sized businesses where the employees intend to continue operations after your death. Typically, the business itself owns the policy and pays the premium. It’s also the beneficiary that receives the death benefit when the insured person dies. Larger organizations tend to establish reporting structures that allow other individuals to succeed a key figure upon their unexpected departure, although key person life insurance could be useful in certain situations.
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Who Qualifies as a Key Person?
Generally, a company-owned life insurance policy only makes sense for a select number of employees whose passing would create a significant financial challenge for the business. This typically includes the small business owner(s), who provides leadership critical to the company’s success.
In addition, an organization may want to insure other top executives whose expertise and business contacts are vital to the company’s well-being. The business might also decide to take out a policy for top salespeople who help generate substantial revenue.
Benefits of Key Person Insurance
Key person insurance provides many important benefits for small businesses.
Funds the Transfer of Ownership
In a partnership, the owners often have a buy-sell agreement that dictates who will purchase the deceased person’s stake in the business. A key person policy can provide the funds needed to acquire the decedent’s shares.
Helps the Company Pay Bills
After an owner or executive dies, the company may experience a temporary loss of revenue. The death benefit for key person life insurance allows the business to pay salaries, rent and other expenses while the organization searches for a replacement.
Makes It Easier to Get Loans
Some commercial lenders require key team members to be insured to protect their investment in the business. Having a key person policy in force could help satisfy this need.
Allows the Business to Pay Severance
Sometimes, the company’s remaining employees may decide to shutter the business, even when the key person is insured. The policy’s death benefit can help the organization pay severance compensation to staff members and cover other costs required to wind down operations.
Choosing the Right Policy for Your Business
Key person insurance can be a permanent or term policy.
Permanent insurance, including whole life insurance, provides guaranteed coverage for the person’s entire life. Permanent coverage is often a good choice for sole proprietors and partners who have a long-term commitment to the business. These policies also build cash value the business can use while the insured person is still alive.
Another option is to purchase term life insurance, which usually has lower premiums. A term policy, which doesn’t have a savings component, provides coverage for a certain number of years before expiring. Often, this simpler form of protection can make sense for nonowners, as the business can generally cancel the policy at any time without paying surrender fees.
How Much Key Person Insurance Do You Need?
A standard rule of thumb is to buy coverage that covers ten times the key person’s salary. But rather than leaning on broad guidelines, you may want to base your policy on the individual’s value to the business. That involves analyzing several factors, including:
- The value of the person’s stake in the company, if existing partners plan a buyout
- The amount of revenue that would be lost when the individual passes away
- The total cost to find and hire a replacement for the insured person
Safeguarding the Future of Your Business
One of the most valuable assets a company possesses is its management team. If the loss of an owner or executive would represent a financial hardship for the company, key person insurance may help keep it afloat.
Consider reaching out to a financial professional to discuss different types of life insurance and see if a key person policy would suit your organization’s needs.
Insurers and their representatives are not permitted by law to offer tax or legal advice. The general and educational information here supports the sales, marketing or service of insurance policies. Based upon individuals’ particular circumstances and objectives, they should seek specific advice from their own qualified and duly-licensed independent tax or legal advisors.
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